Using spectral element method to solve variational inequalities with applications in finance

Under the Black–Scholes model, the value of an American option solves a time dependent variational inequality problem (VIP). In this paper, first we discretize the variational inequality of American option in temporal direction by applying the Rannacher time stepping and achieve a sequence of elliptic variational inequalities. Second we discretize the spatial domain of variational inequalities by using spectral element methods with high order Lagrangian polynomials introduced on Gauss–Legendre–Lobatto points. Also by computing integrals by the Gauss–Legendre–Lobatto quadrature rule we derive a sequence of the linear complementarity problems (LCPs) having a positive definite sparse coefficient matrix. To find the unique solutions of the LCPs, we use the projected successive over-relaxation (PSOR) algorithm. Furthermore we present some existence and uniqueness theorems for the variational inequalities and LCPs. Finally, theoretical results are verified on the relevant numerical examples.